Net absorption spikes as job growth continues

The Greater Phoenix office market strengthened during the second quarter, fueled by continued tenant demand for space. Net absorption totaled more than 1 million square feet during the quarter, a figure that has been matched only a few times in the past several years.

Tenant demand is being driven by a steady pace of hiring, including continued gains in office-using sectors. Employment in Greater Phoenix is coming from both businesses entering the market, as well as existing companies expanding established operations.

The ongoing tenant demand in the marketplace is driving the local vacancy rate lower, but the pace of rent growth has leveled off in recent quarters. Average asking rents are up less than 3 percent from one year ago, even as the vacancy rate has dipped to its lowest level in more than a decade. The slowing pace of rental growth is not likely to persist given the strong demand in the market. Overall rental rates could receive a boost from the delivery of new spec projects in the coming quarters. The average asking rent in spec buildings that are currently under way is about 20 percent higher than the average asking rent on existing Class A buildings.

Sales of office buildings have been quite active thus far in 2018, as investors are responding to the improving market conditions. Transaction counts for the first half of 2018 are up about 10 percent from the first half of last year and up more than 15 percent from the average levels over the past five years. Prices are also generally trending higher, while cap rates are averaging approximately 7 percent.

Key Takeaways:

  • The Greater Phoenix office market had a strong second quarter. Net absorption totaled more than 1.1 million square feet during the quarter, and net absorption year to date is up more than 60 percent from the first half of 2017.
  • Vacancy dipped below 15 percent, ending the second quarter at just 14.7 percent. The rate is now 140 basis points lower than one year ago.
  • Rents continue to rise, albeit at a more modest pace than in recent years. Asking rents ended the second quarter at $24.69 per square foot, 2.8 percent higher than one year ago.
  • Investment activity accelerated, the median price rose and cap rates inched lower during the second quarter. To this point in 2018, improving property fundamentals are outweighing any drag on the investment market from rising interest rates.

Outlook:

The momentum built in the Greater Phoenix office market during the second quarter is likely to carry over into the second half of this year. Healthy levels of net absorption should allow the local vacancy rate to remain near its current ranges, even as new spec projects are delivered in the market. More than 800,000 square feet of spec construction is slated to come online during the second half of this year, and 2018 is expected to be one of the most active for spec deliveries in the past decade.

During the second quarter, there were a handful of prominent corporate announcements that should bolster local job growth and tenant demand in the coming quarters. Accounting and consulting firm Deloitte announced plans to open an operations center in Gilbert, a move that could result in as many as 2,500 jobs in the area. Additionally, Nationwide Insurance announced plans to build a regional headquarters in Scottsdale that would ultimately have 2,200-3,000 workers.

The outlook for the investment market has not changed considerably over the past few quarters. To this point in the cycle, interest rate increases have been absorbed without corresponding upticks in cap rates and prices have continued to push higher. Looking ahead, the prevailing market themes are likely to persist, but there could be some upward pressure on cap rates if interest rates continue to inch higher.